What Is Don't Fight the Fed?

Definition & Examples of Don't Fight the Fed

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"Don't fight the Fed" is an investment policy that suggests investors should align their choices with the actions of the Federal Reserve System, or Fed. Aligning with the Fed generally means buying stocks when interest rates are low and avoiding stocks when interest rates are high.

What Is 'Don't Fight the Fed'?

"Don't fight the Fed" is a policy that advises aligning your investments with the current monetary policies of the Federal Reserve System, rather than against them.

The Federal Reserve System, known as the Federal Reserve or the Fed, is the central bank in the United States of America. It was created in 1913 to make the financial system of the U.S. more safe, stable, and flexible.

To work with the Fed's policies, you would invest more aggressively when the Federal Reserve is lowering interest rates and more conservatively when it is raising interest rates.

The saying suggests an investor should stay fully invested (up to their respective risk tolerance) when the Fed is actively lowering interest rates or keeping them low. So an investor with a high tolerance for risk may be comfortable allocating 100% of their portfolio to stock funds when monetary policy is "easing" or "accommodative," meaning the Fed is keeping interest rates low to spur economic growth.

How 'Don't Fight the Fed' Works

One of the responsibilities of the Federal Reserve is to regulate the economy through interest rates on borrowing. As the Fed raises and lowers these rates, it creates different conditions for businesses, which in turn creates different opportunities for investors.

The primary responsibilities of the Federal Reserve are:

  • Establishing the nation's monetary policy by influencing money and credit conditions, such as raising or lowering interest rates, to promote stability and employment
  • Supervising and regulating banks and other financial institutions
  • Maintaining the stability of the financial system and containing risk in the financial markets
  • Providing financial services to the U.S. government, foreign institutions, and other U.S. institutions

When the Fed sets low rates, is does so to help the economy expand by allowing consumers and corporations to borrow money more cheaply and decrease expenses. This translates into higher corporate profits.

When the Fed starts to raise rates, it does so to prevent the economy from growing too quickly and fueling higher rates of inflation. This limits the level of borrowing consumers and businesses do, slowing corporate expansion and profits.

Corporate stocks do well when their balance sheets are strong, making these stocks a good investment when interest rates are low and a less good investment when interest rates are high. This is the strategy underlying "don't fight the Fed."

Rising interest rates also coincide with the late phase of the business cycle, which immediately precedes a bear market and recession of a growth cycle. Therefore, a bull market for stocks typically peaks before the economy peaks. This is because the stock market is a forward-looking mechanism or "discounting mechanism."

You would be fighting the Fed if you remained fully invested when the Federal Reserve is raising interest rates or if you are conservatively invested when they are lowering rates or keeping them low.

Is 'Don't Fight the Fed' Worth It?

When the Fed sets monetary policy, it looks at historical data, usually from one to three months back, to provide measurements of economic health. For example, if an economic recession began today, it would not be reported by economists with certainty for at least one month.

The stock market has been called a "leading economic indicator" because it can (but does not always) predict the near-term future direction for the economy.

This lag time between the economy and monetary policy can lead to different scenarios where investing counter to the Fed's current policy could put you ahead of the economic curve.

In general, investors shouldn't base their decisions solely on the policies of the Federal Reserve. There are many other factors that impact the economy including:

  • Geopolitical changes
  • Oil and energy costs
  • Global health crises
  • Trade policy

The interest rates and monetary policy set by the Fed are one of many factors that influence stock prices and economic trends, all of which investors should use to make their decisions.

Key Takeaways

  • "Don't fight the Fed" is an investment policy that suggests investors should align their choices with the actions of the Federal Reserve System or Fed.
  • Aligning with the Fed generally means investing aggressively when interest rates are low and conservatively when interest rates are high.
  • When the Fed sets low rates, it helps the economy expand, allowing corporations and consumers to borrow money more cheaply.
  • When the Fed starts to raise rates, it does so to prevent the economy from growing too quickly and fueling higher rates of inflation.
  • Fed policy is just one of many economic indicators that investors should pay attention to.

Article Sources

  1. U.S. Department of State. "Briefings - Foreign Press Center - Stifel: 2020 Market Outlook." Accessed July 15, 2020.

  2. Board of Governors of the Federal Reserve System. "FAQs: What Is the Purpose of the Federal Reserve System?" Accessed July 15, 2020.

  3. Board of Governors of the Federal Reserve System. "FAQs: What Does the Federal Reserve Mean When It Says Monetary Policy Remains "Accommodative"?" Accessed July 15, 2020.

  4. Board of Governors of the Federal Reserve System. "FAQs: How Does Monetary Policy Influence Inflation and Employment?" Accessed July 15, 2020.

  5. Board of Governors of the Federal Reserve System. "FAQs: Why Do Interest Rates Matter?" Accessed July 15, 2020.